China’s major banks may have pledged that last month’s tragic high-speed rail crash would not prompt them to raise the cost of borrowing for the Ministry of Railways, but the market is proving to have no such reservations.

On Monday the Railways Ministry, one of the biggest issuers of debt in the country, launched its first bond sale since the crash on July 23. It sold all 20 billion yuan ($3.11 billion) worth of three-month bills on offer in the interbank market, but promises to pay an annualized return of 5.55%, a relatively high rate for government paper.

“The railway ministry had to set a sky-high indicative yield range to ensure sufficient demand for its debt offering at a time the latest deadly train crash has hurt investors’ confidence in holding the ministry’s paper,” said a Shanghai-based trader with a local brokerage. The range was set at 5.22% to 5.72%.

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Analysts have been warning for the last couple of weeks that the fallout for the ministry from the crash is likely to be as much financial as political. While there is no doubt the ministry can make good on its debts – after all, it’s part of the government – the accident has turned the popular mood against it and the high-speed rail project it’s been racking up the debts to fund.

At the end of June, the Ministry of Railways’ outstanding debt rose to 2.09 trillion from 1.98 trillion yuan at the end of the first quarter. That accounts for roughly 5% of China’s gross domestic product, up from about 2% in 2007.

Moreover, data disclosed by the ministry in a recent bond prospectus raised questions about its ability to generate enough revenue to have the cash to cover its debt repayments, raising the prospect of a bailout of its finances and even a dismemberment of the ministry itself.

Concerns that the ministry would see its cost of borrowing go up despite its sovereign rating were countered last week by local media reports that the big five banks would continue to lend to it (in Chinese).

“Our loans to the railway network are of good quality and we won’t stop our cooperation with the Railway Ministry,” China Construction Bank said in response to questions from the Wall Street Journal. “The loans we make to the ministry are priced solely on market-based and commercial principles.”

Investors weren’t similarly inclined. Even before the crash, Ministry of Railways paper was losing popularity. In its last sale, only a couple of days before the crash, the 20 billion yuan worth of one-year bonds it had on offer weren’t fully subscribed to.

Monday’s interest rate was higher than the 5.20% rate on the ministry’s three-month bills traded on the secondary market. It also compared unfavorably with the 4.12% rate on five-year bonds sold by the Ministry of Finance on behalf of local governments Monday.

Ministry of Railways bonds aren’t a perfect substitute for Ministry of Finance bonds. Typically they offer a higher yield because investors need to pay tax on the interest of Ministry of Railway bonds, whereas Ministry of Finance bonds are tax-free.

Still, there’s little doubt the market is punishing the Railways Ministry. Even the three-month maturity on the debt appears to be an exercise by the ministry in testing the waters with investors. The purported use for the bond proceeds – to buy trains and finance railway construction – would seem to warrant a significantly longer time commitment. A short maturity means a lesser commitment from investors already of two minds about whether the ministry should continue aggressive expansion of the high-speed rail network.

On the other hand, maybe investors are wary of buying longer-term debt from an agency – government or otherwise – that might not be around for much longer.

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